QUESTIONS

Distinguished teachers, the following questions are about auditing and assurance in Hong Kong. Please use Hong Kong Accounting Standard to answer the following questions. Thank you!

Question 1 - Headquartered in Hong Kong, Overseas Bank is a medium-sized Chinese bank with 50 branches situated on the Hong Kong Island, Kowloon and the New Territories. Overseas Bank provides full banking services, including automatic teller machine (ATM) service.

Overseas Bank has expanded its banking operation rapidly in the New Territories. As of to-date, Overseas Bank has 20 branches in the New Territories and is planning to extend the provision of ATM service to each of the 20 branches in the New Territories.

Required: Design the security controls that should be placed on the ATM and related computer programs.

Question 2 - Lee Co. designs and manufactures luxury motor vehicles. The company employs 300 staff and consistently makes a net profit of between 10% and 15% of sales. Lee Co is not listed; its shares are held by 8 individuals, most of them from the same family.

The executive directors are drawn mainly from the shareholders. Lee Co does not have non-executive directors because the Hong Kong Companies Ordinance does not require any. The executive directors are very successful in running Lee Co from their training in production and management techniques.

The board is considering a significant expansion of the company. However, the company's bankers are concerned with the standard of financial reporting as the financial director has recently left Lee Co. The board is delaying provision of additional financial information until a new financial director is appointed.

No internal audit function is established and the executive directors are having growing concerns over the various business risks faced by the company as a result of expansion. The company's auditors, Lam & Co, are appointed by and report to the board. The board of Lee Co is considering a proposal to establish an audit committee. The committee would consist of one executive director and three new appointees. One appointee would have a non-executive seat on the board of directors.

Required: Discuss the benefits to Lee Co of forming an audit committee (Your answers should refer to the information in the case).

Question 3 - Eastern Hotels Group Limited ("Eastern") is principally engaged in hotel operations and management. As at 31 December 2015, Eastern owns and operates 30 hotels in Hong Kong and Mainland China.

Payroll expenses account for more than 60% of Eastern' s operating expense. In order to retain well trained employees, Eastern offers attractive remuneration including housing allowances, performance bonuses, and various other incentive schemes. Salaries are paid on a monthly basis on the 5th day of the following month. Eastern uses PeopleSmart, a specialized payroll system, for the processing of its payroll. Approval of the monthly payroll is done electronically by PeopleSmart.

Lau & Co CPA have been the auditors of Eastern for many years. This year, a new engagement partner has been assigned to the audit of Eastern due to partner rotation.

Required: You are the audit manager in-charge of the Eastern audit for the 2015 year end. The new engagement partner has asked you to write notes in the factors to consider in using computer-assisted audit techniques (CAATs) and possible computer-assisted audit techniques in auditing Eastern' s payroll related expenses.

Question 4 - Chan Kee Restaurant Limited

History and Business Operations

Mr. John Chan started a cooked food stall in Wanchai during the late 1960s and was renowned for delicious gourmet cuisine. In 1976, John invented the special dishes of roasted chicken and chicken meat sausages which became very popular amongst local customers. Good business provided John with the resources to buy a five-storey building in Kowloon City, which he lived in with his wife and three teenage sons on the top two floors.

Mr. John Chan incorporated Chan Kee Restaurant Limited (Chan Kee) in 1980, and transferred his cooked food stall business and the ownership of the building to Chan Kee. This cooked food stall business turned into a prestigious restaurant on the ground floor and the first two floors of the Kowloon City building. The business continued to prosper, and many local customers as well as tourists have been drawn in by its specialty roast chicken and chicken meat sausages.

Peter and David, the two older sons of John, assisted him in running Chan Kee after the completion of their secondary school education. During the 1980s and 1990s, Chan Kee won various favourite food and good dining awards, and was featured in newspapers and magazines in Hong Kong and around the world. Chan Kee has now become a popular dining place for celebrities, politicians and tycoons.

To expand its business, Chan Kee rented the shop next door in 2008 under a 5-year lease agreement. The lease term is a HK$1 million upfront payment with monthly rental based on 0.05% of the overall revenue of the restaurant business subject to a minimum of HK$300,000. Chan Kee incurred HK$1 million to decorate the shop. In January 2010, an expenditure of HK$200,000 was incurred to refurbish the shop.

Chan Kee's dishes are also served on board the flights of local airlines. Roast chicken and chicken meat sausages are packed and sold in the on-board duty-free shops in order to take advantage of the growing demand of travellers to shop for souvenirs.

Chan Kee decided to export packed roast chicken and chicken meat sausages. On 31 August 2010, Chan Kee purchased a warehouse located in Mongkok as the processing centre for packed roast chickens and chicken meat sausages. The warehouse was purchased for a consideration of 5% of Chan Kee's shares (through allotment of shares at nil consideration). After the purchase, Peter still maintains the controlling interest. The directors believe that these shares are approximately valued at HK$40 million.

The Dispute

John passed away in 2000, and Peter and David have each inherited 45 percent of the shares in Chan Kee. Raymond, the youngest son, who does not take part in the management of Chan Kee, has been given the remaining 10 percent stake. Chan Kee has been jointly managed by Peter and David since then.

Mr. Kwok is a Certified Public Accountant (Practising), and his firm, KKK & Co., has been the auditor of Chan Kee since 2005. Over the years, Chan Kee has received unqualified audit opinions on its financial statements from KKK & Co. Chan Kee does not have an audit committee and has been relying on KKK & Co.'s management letter as a way to monitor the operating effectiveness of its internal controls.

Since 1 January 2008, there have been signs of unrest at the management of Chan Kee. Peter bought Raymond's 10-percent share and has become the majority shareholder. Peter has also put his daughters onto the management team of Chan Kee. The two daughters of Peter, Dorothy and Victoria, were appointed as directors of Chan Kee in 2008. In a number of Board meetings of Chan Kee, Dorothy and Victoria appear to be very supportive of their father. Their votes happen to be always the same as all of their father's votes. David believes that Peter has been trying to manipulate the board of directors through the appointment of his two daughters. Peter explained that it is just because his two daughters are as competent as he is and therefore cast the same vote as he does.

In July 2010, Chan Kee entered into a tenancy agreement with Dotty Limited, a company wholly owned by Dorothy, to let the third floor of the Kowloon City building to Dotty Limited for a monthly rental of HK$100,000. The third floor of the building can be sold out separately, if required.

David has made various allegations against Peter regarding the abuse of powers in running Chan Kee's business. The dispute was intensified when David discovered that there is an irreconcilable difference between the stock of gift vouchers (i.e. cash coupons) physically kept by Chan Kee and those in the ledger during the summer of 2010. The shortfall of coupons below the recorded quantity has a total face value amounting to HK$1 million.

In October 2010, David applied to the Court to wind up Chan Kee by arguing that it was a last resort since he was unable to accommodate Peter any more. Despite the winding-up petition, Chan Kee's business continues and appears to be profitable. Peter has sought to have the winding-up petition struck out, putting forward an offer to buy out David's shares and arguing that Chan Kee remains an ongoing and profitable business. Before the Court makes a decision on the winding-up petition, Peter and David discussed the matter amicably and have decided to appoint a joint valuer for the purpose of determining a fair price for Chan Kee. Also, Peter considered the possibility of listing the shares on the Hong Kong Stock Exchange after the buy-out.

Discussion: Discuss three possible improvements to Chan Kee's corporate governance.